Archives for 2022

There’s good news in 2023 for multifamily says a CBRE report. Overall demand should hold steady. But a moderating force of new units is coming online, so don’t expect the results of the previous two years.

“It appears 2022 will be a turning point for multifamily fundamentals,” CBRE wrote. “Leasing activity was unseasonably slow in the summer when demand is typically at its strongest. This coincided with a steady pace of new deliveries, causing the overall vacancy rate to rise by 150 bps in Q2 and Q3 2022, pressuring rents.”

And yet, the firm says that still-strong housing fundamentals should keep occupancy rates higher than 95% and rent growth at 4%. That is far from the vacancy rates below 3% and double-digit rent increases that the pandemic ultimately brought, and rents won’t keep pace with ongoing inflation.

That may not ultimately be a big problem for multifamily property owners who, with previous increases, should have found themselves ahead of the game going into current conditions.

CBRE estimates that 3.5 million new market-rate units will be needed by 2035 to meet demand. The firm tracks 69 markets and estimates 796,000 units that are under construction. Of those, 450,000 are on track to deliver in 2023. That’s an additional 2.3% of inventory.

If that pace keeps up for the next 12 years, that would more than meet the number of units needed. Only, there are situations that could slow down construction and delivery. New starts are slowing because construction financing is getting more expensive and difficult to arrange and the Federal Reserve in mid-December said, “The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.”

While attention is often on interest rates, also critical is the reduction of its balance sheet holdings of bonds. During the easy money times going into the pandemic, the agency kept the multifamily market going by purchasing huge volumes of mortgage-backed securities from Fannie Mae and Freddie Mac. That’s no longer the plan. “In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve’s Balance Sheet that were issued in May,” the Fed further noted. That’s a big drop in a major source of liquidity for housing.

Offsetting that is potential slowing of housing demand growth. CBRE noted that as “households grapple with economic uncertainty, household formation and new renter demand will struggle to keep pace with supply. Vacancy rates will continue rising, albeit at a slower pace, and drift toward the 20-year average of 5%.”

Source: “This Year Marked a Turning Point for Multifamily Fundamentals“

Nearly three-fourths of investors believe commercial real estate assets are overvalued, which could mean storm clouds are on the horizon for the sector next year as a recession looms.

Preqin’s 2022 November investor survey reveals that 74% of investors believe real estate assets are overvalued, with fund managers saying they expect valuations to fall. Globally, 249 funds had closed as of the end of the third quarter, 46% of the full-year total in 2021, with aggregate capital totaling $101.9 billion (48% of 2021’s $210.7 billion total).

Value-added funds accounted for almost 40% of funds closed by end of the third quarter, an increase over the long-term average of 32%.  Valued-added funds accounts for 35% of aggregate capital raised, or $35.6 billion, “far above” the 2001 to 2021 average of 27%, Preqin analysts say.

“Value-added funds are well placed to capitalize on repositioning older office stock, for example, toward modern ways of working” Preqin analysts note in a summary of the 2022 global report. “The strategy offers the ability to commit capital to significantly improve the quality and rental prospects of an asset. Providing the opportunity to generate returns in the double digits, this strategy is favored by many fund managers and investors because of the breadth of opportunities to put capital to work.”

Ultimately, however, “strong headwinds” persist as interest rates likely will continue to tick upwards globally into 2023 and asset values fall.

“The real estate market appears to be in the preliminary phase of a readjustment,” says Dave Lowery, SVP, Head of Research Insights at Preqin. “After benefiting from low rates for an extended period, the market is adjusting to higher rates – a trend witnessed in many parts of the world. This will mean falling prices for even the best quality assets, and if we see recessions in some markets, occupier demand may also weaken, with implications for rents. Investors may well sit on their hands and wait for the market to settle before making any new allocations, while fund managers will need to find agreement on pricing for deal activity to increase.”

Source: “Most Fund Investors Think CRE Assets Are Overvalued“

2022 has been a tumultuous year for the CRE industry and more volatility is expected in 2023. Below are my Top Ten CRE Predictions for 2023.

Short-term interest rates will increase by at least 1.0%

The Federal Reserve will continue to increase the federal funds rate even after the latest .50% increase at the Fed meeting on 12/14/22, from its current 4.25% to 4.5%-5.0% by the summer of 2023. This will create more havoc in the CRE industry as funding costs and cap rates will increase substantially.

Capitalization rates will increase by 1.0% to 2.0%

As the Fed increases short-term interest rates, cap rates for CRE deals will continue to rise with the increase in short-term interest rates and the average cap rate for all properties will rise to 7.0%+ from 5.5%. Many investors are buying and developing new projects with negative leverage which is very risky and if future rent increases are lower than projected, will result in lost equity.

Cap rates for apartment and industrial properties will increase significantly

Cap rates for the two hottest CRE sectors during the last five years will increase substantially from 3.0%-4.0% to 5.5% to 6.5%+. The projected growth in rents for these two sectors will decline substantially, which will force higher cap rates on sellers.

The bid-ask spread for CRE property sales will begin to narrow

The bid-ask spread for CRE acquisitions is currently wider than the Grand Canyon, with sellers seeking cap rates of 4.0% to 6.0% and buyers offering cap rates of 6.0% to 7.0%+. However, the bid-ask spread will narrow significantly as sellers become more realistic regarding property values. This will lead to more transaction activity in 2023.

Hotels will be the most favored investment

The hotel industry which was decimated in 2020 and 2021 by the Covid pandemic is beginning to turn around with very positive fundamentals and will be the favorite CRE investment next year. Many hotels were sold in 2021 at 60% on the pre-pandemic dollar and there are still discounts in the sector. There is a huge pent-up demand for both business and leisure travel and since hotels have one-night leases, they are the best protection against higher inflation.

There will be a sizable increase in CRE defaults and foreclosures

Higher interest rates and a slowing economy or recession will cause a sizeable increase in CRE defaults and foreclosures. This will depend on how aggressive the Federal Reserve is in increasing short-term interest rates. There are many properties that are overleveraged and with a slowing economy, will see substantial vacancy increases that will lead to higher foreclosures and defaults. Investors should begin raising capital for distressed and workout funds.

The sunbelt states will continue to attract the majority of CRE capital

The high-growth, low-tax, Sunbelt states like Florida, Tennessee, Texas, Nevada, North Carolina, Arizona, Georgia, and others will see much higher CRE investment than the high-cost and high-tax states. Investors and lenders see less risk and are more comfortable investing and lending in these locales.

Office investments and valuations in the gateway cities will continue to decline

Office building investment and development in the gateway cities of New York, Chicago, Los Angeles, San Francisco, Seattle, Oakland, Portland, and Atlanta will continue to see a dearth of new investment and capital due to their high crime rates and low quality of life. Office utilization in these markets will also continue to be soft at less than 50%.

Industrial rents will decline more than 10%

The booming industrial market where cap rates compressed to below 4.0% and average asking rents increased about 50% over the last seven years will see rent levels declining over 10%. Higher interest rates and inflation has curtailed the purchase of goods by consumers and the development of over 700 million square feet of new space will soften rents nationally. Some of the hottest markets in the last few years like the Inland Empire, Orange County, San Francisco, and Miami will lead to falling asking rents.

The single-family rental market will see reduced rents and higher lease defaults

The single-family rental market, which has boomed in the last few years with double-digit annual rent increases and 95%+ occupancies, will see lower or flat rent increases and vacancies and lease defaults will rise. A sizable portion of the tenancy have low credit ratings and when the economy tips into recession, these tenants will be more prone to lose their jobs and default on their lease contracts.

Source: “Top Ten CRE Predictions for 2023“

Silver linings are hard to find lately in total construction starts data.

According to the Dodge Construction Network, starts overall fell by 18% in November with each nonresidential building starts down 25%, nonbuilding shed 21%, and residential starts dropped 5%.

Meanwhile, the National Association of Home Builders’ monthly confidence index fell two points to 31 in December, marking the 12th month in a row that the index has fallen.

Outside of the pandemic, the December reading of 31 is the lowest level since mid-2012.

Volatility Marks the Year in Construction

In what has been a volatile year, Dodge did point to total construction starts at a 14% higher rate than this point in 2021.

Lately, it’s been large projects carrying the index – such as chip plants and EV battery plants – but those weren’t on the docket last month, “hence the noticeable decline,” Dodge said in a release.

“Month-to-month volatility in construction activity continues to reign supreme as uncertainty mounts over the economy in 2023,” Richard Branch, chief economist for Dodge Construction Network, said in prepared remarks.

“Higher interest rates and fear of recession are first and foremost on the mind of most builders and developers, and potentially restraining starts activity.”

Branch said that however, as some material prices head lower and more public dollars come into the market for infrastructure and manufacturing projects, the year is ending with a fair bit of momentum.

The Month’s Biggest Projects

The largest nonbuilding project to break ground in November was a solar farm in Madison County, Wisc.

The largest nonresidential building project to break ground in November was the $1.1 billion Harbor-UCLA Medical Center in Torrance, Calif.

The largest multifamily structure to break ground in November was the $345 million 601 N. Central Ave. mixed-use building in Phoenix.

Source: “Construction Starts Tumble in November“